A down week

Market analysis
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5/4/2018

After April’s strong bounce, markets edged lower in the first week of May. Economic data continued to suggest the economy was slowing both in Europe and the US, a big contrast with the surge seen at the end of 2017.

The FOMC meeting held no surprises and the bank confirmed that its 2% inflation target was symmetrical, a reminder that it sees no need, even though core PCE has recovered to 2%, to increase the pace of tightening if inflation continues to edge higher.

Preliminary data on European inflation were slightly disappointing as the core figure fell to 0.7% YoY, undoubtedly due in part to seasonal factors. Nevertheless, it will reinforce the ECB’s cautious mood now that it has started to move towards monetary normalisation. And in the US, yields on benchmark US Treasuries have eased. That said, the recovery in inflation there has helped the US dollar rebound but has put emerging country debt markets under pressure. In only 2 weeks, yields on the EMBI index have widened by a significant 35bp vs. US bonds while currencies in countries with hefty current account deficits like Argentina, Turkey and South Africa have tumbled. Emerging countries had previously weathered the Fed’s interest rate hikes but the countries with the biggest imbalances are now starting to look fragile.

European equities

With many earnings reports in, and in spite of significantly fewer business days and unfavourable weather for a number of sectors, first quarter growth is running at 5.4%, or better than expected. This means higher-than-expected currency effects and material prices have been offset thanks to strong momentum from industrials, tech and discretionary consumption (i.e. luxury).

The US dollar strengthened further against the euro and broke below 1.20, a boon for Europe's export stocks. Semiconductors stocks like Dialog, AMS, STM and Infineon gained on upbeat iPhone sales. The DAX made up some of its lag thanks to major auto and pharma exporters. Italy was also favoured by US dollar-sensitive stocks like Brembo, Ferragamo, Tenaris and CNH.

Tenaris also gained on its excellent results while CNH raised its guidance for 2017 and announced a $700m share buyback. Like for like first quarter growth at Thales blew past expectations by jumping 7.2% while new orders soared to €3bn. All the group's 2018 objectives were reaffirmed. Capgemini surprised on the upside with 6.1% in internal growth and Saint-Gobain reassured markets by raising prices by 2.1% in the first quarter; the second quarter should also be strong. Veolia confirmed it was on an uptrend with like-for-like sales accelerating to +5.4% in the first quarter, mainly due to a recovery in volumes with waste collection up 3%.

Disappointments included Bayer which revised down its 2018 objectives due to larger-than-expected currency effects.

The big challenge facing the group is the tie-up with Monsanto which it hopes to conclude in the second quarter. AXA’s revenues were mixed but its solvency ratio hit 221%, or 15% more than expected. The listing of its US affiliate could act as a rerating catalyst. Société Générale’s net earnings fell short of expectations and point to a difficult 2018 ahead for retail banking in France. The bank is, however, reportedly about to reach an agreement on its first two US legal disputes. Like-for-like first quarter growth at Nexans was disappointing but management confirmed that the second quarter would see a sequential improvement.

Sainsbury and Asda are to merge with the new entity moving to first place in the UK retail charts ahead of Tesco. T-Mobile US (Deutsche Telekom) is to acquire Sprint. Both stocks came under attack on fears the regulatory authorities would insist on heavy asset sales before agreeing to the deal.

US equities

US markets had a down week with the S&P losing 1.4% and the Nasdaq ending 0.4% lower. The retreat was prompted by various factors including disappointing macro data and the stronger US dollar. PCE inflation, the Fed’s preferred gauge, came in at 1.9% in April, or in line with expectations. Manufacturing ISM fell from March’s 59.3 but was still well entrenched in expansionist territory. Non-manufacturing ISM followed suit, falling from 58 to 56.3.

The Fed meeting produced no major developments apart from a slightly accommodating shift as the bank said it would put up with inflation moving above its 2% target. At the same time, it noted that growth had slowed compared to the previous quarter and removed the reference to “growth strengthening in recent months” that had featured in the March statement. Bond yields quite naturally continued to ease with the US 10-year Treasury falling from last week’s 3% to 2.94%.

The M&A market returned in force with T-Mobile and Sprint unveiling a $26.5bn tie-up.

The aim is to reach critical mass in mobiles to compete with Verizon and AT&T. But most importantly, the competitive environment would be eased if the deal were to receive regulatory approval as there would be 3 rather than 4 operators. In the oil sector, Marathon Petroleum is to buy Andeavor (refining) for $23bn.

With 401 fourth quarter company results in, 358 have beaten expectations and 40 have missed them. Aggregate EPS is 25% higher than in the first quarter of 2017 and 6.6% more than consensus expectations. The other big news this week came from Apple which reported upbeat results driven by iPhone sales and an increasing contribution from its Services division (AppStore, Apple Music, etc.), which has fatter margins. Tesla reported a 20% increase in sales, but the share suffered heavy selling after CEO Elon Musk’s earnings call when he refused to reply to analysts’ questions and said questions on working capital requirements were “arid”.

Japanese equities

In a short week with only two business days, Tokyo was little changed. The Nikkei 225 index edged up 0.17% on Tuesday and promptly moved back 0.16% down on Wednesday due to marginal profit taking on the domestic demand stocks and defensive stocks that had recently been driving the market.

Ahead of a long holiday, few investors took positions which were likely to move prices. Many investors stayed on the sidelines as key events like the US FOMC meeting and US April job data were scheduled to be released during the break.

With the yen weaker at around 109 to the US dollar, excessive worries over the risk to tech earnings guidance receded. However, Sony lost 5.87% after releasing a downbeat earnings outlook for FY 2018 following the strong recovery seen in 2017. And Fujifilm Holdings fell 6.40% after being forced to review its bid on Xerox in the US.

Emerging markets

The EM index fell amid increased volatility due to US rate fluctuations and the stronger dollar after the May 2 FOMC led to only a slight change in the bank's communique.

China's official manufacturing PMI in April came in at 51.4, or better than expected. Strong performance from PMEs offset relative weakness in large companies. The final version of the new rules on Chinese active investment products and services will allow more time than expected for shadow banking loans to be cleaned up. Beijing's message is clear: deleveraging must continue but with increased efforts to stabilise the economy. The war of words over trade between China and the US continued to weigh on market sentiment ahead of the official US delegation’s trip to Beijing to start real talks.

Following its disappointing first quarter results, BYD was equally pessimistic at the analysts’ meeting and said the outlook was clouded by reduced subsidies for electric vehicles. Moutai (premium white liquor) saw first quarter sales up 31.2% while profits jumped 38.9%. Its operational efficiency is among the best in its peer group. South Korea’s Samsung Biologics was found guilty by its supervisory authority of providing fraudulent valuation data for its Samsung Bioepis subsidiary ahead of its November 2016 IPO.

India’s manufacturing PMI rose to 51.6 but higher oil prices will hit the economic outlook. Brazil's Itau reported disappointing results due to higher provisioning of large company exposure. But new retail loans increased 33% YoY. Mexico’s manufacturing and services PMI weakened in April along with company confidence levels, a big contrast with improving consumption. Argentina’s central bank once against raised its benchmark rate by 300bp to 33.25%, a 600bp increase in only two weeks.

Commodities

Oil prices were largely unchanged, but the market remained nervous as investors watched for news on the Iran nuclear agreement. Tehran said it would exit the deal if Donald Trump went through with this threat to walk away from it.

Meanwhile, supply-side tension remained high. OPEC exports have fallen by 120,000 b/d in recent weeks if tanker movement data are any indication. At the same time, Angolan output, currently running at 1.5 million b/d vs.1.62 million at the end of 2017, is expected to fall further to 1.38 million b/d in coming months. The country will subsequently benefit from the Total-run Koambo field (230,000 b/d capacity) resuming operations in the second half. Venezuela’s oil minister said that in the worst-case scenario, production should drop to 1.2 million b/d by end 2017 from 1.47 million today (and close to 2 million last September). According to the EIA, US output rebounded by 260,000 b/d in February to 10.26 million b/d after being hit by severe winter weather. Demand remained strong, rising by 460,000 b/d in February, which is why inventories continued to fall.

The gold ounce drifted lower but, despite the US dollar strength, remained above its $1,300 support level. The US Fed admitted that inflation was now running close to its 2% target but said it saw no reason to increase the scheduled pace of rate hikes. This is good news for gold. According to World Gold Council data, central banks bought 116 tonnes in the first quarter, a 42% increase over a year and the strongest absolute figure in 4 years. ETF inflows remained strong, with an additional 32 tonnes, but the pace was slower than in the first quarter of 2017 which saw an increase of 96 tonnes. ETF assets now stand at 2,400 tonnes, the highest level since April 2013.

Corporate debt

Credit

It was a quiet week with little primary or secondary activity. On Thursday, spreads widened as investors took profits, especially on recent issues. Financials moved lower throughout the week on heavy selling.

Spain’s Aldesa (B2, construction), is to raise €300m with a 7-year maturity and a coupon around 8.5%. Italy’s Nexi (payment services) is to issue a fixed and floating-rate 5-year bond with a coupon around 4%.

Adler Pelzer (B1/B+, car components), released upbeat 2017 results with growth across all regions. Sales rose 10.5% and EBITDA was 12% higher. Huntsman (Ba1/BB+, chemical products), also had an excellent first quarter with sales up 18.8% and EBITDA 55.8% higher. The group reaffirmed its objectives and intends to continue with its acquisitions strategy. Nyrstar (B3/B-, metals), had a poor first quarter. Sales edged 3% higher but current EBITDA dipped 5%. Management nevertheless stuck to its objectives despite bad news on metal processing fees and the departure of its CFO. Spain’s Grifols (Ba3/BB, pharma) had mixed results with sales and EBITDA down 3.6% and 7.7% over a year due to currency effects and the US dollar in particular. Like-for-like sales, however, rose 7.4%.

Teva (BB/Ba2) saw some of its bonds rise by several points. First quarter results were better than expected thanks to cost cutting and growth in speciality drugs in the US and generics in Europe. The group revised up its guidance for 2018.

T-Mobile US, a subsidiary of Deutsche Telekom and Sprint, a Softbank subsidiary, have agreed to merge via a share swap (9.75 Sprint shares for each T-Mobile share). Deutsche Telekom will own 42% of the merged entity and Softbank 27%.

Convertibles

In the US, healthcare services company, Teladoc issued a $250m, 7Y, 1.375% coupon convertible for working capital purposes and possible acquisition financing. Another deal in the US came from cloud contact center software company, Five9, which issued a $225m, 5Y, 0.125% coupon convertible to refinance an existing revolver and for general corporate purposes.

In company news, Maisons du Monde (French furniture and decoration retailer) posted solid first quarter results with sales of €255m (+11.5% YoY) boosted by online (+15.1%) and international sales (+14.3%). The company also announced the acquisition of US homeware retailer, Modani, and the appointment of Julie Walbaum as new CEO, replacing Gilles Petite. Qiagen reported first quarter sales up 12% YoY, around 2% ahead of consensus, driven by Academia, Pharma and Molecular Diagnostics. The German medical testing company also reiterated its FY2018 outlook for +6/7% organic sales growth.

Despite strong auto and industrial segments, NXP Semiconductor reported first quarter sales of only $2.27 bn, down 7.6% QoQ and below consensus, amid weak demand in the wireless infrastructure segment. The stock fell over 10% following the announcement.

Medical device manufacturer, Insulet reported a 19.5% increase in first quarter sales to $123.6M driven by strong US sales of the company’s Omnipod insulin delivery patch pump; the company also raised its 2018 sales guidance to $565-580m.